| Scope and method of study. The purpose of this study is to employ the NATREX approach to verify the fundamental determinants of the real exchange rates. The NATREX means NATural Real Exchange Rate, and it is a moving equilibrium exchange rate responding to continual changes in exogenous real fundamentals, and is built on a general equilibrium concept that stresses the fundamental real terms such as the savings rate and productivity on the trend of the real exchange rate in an open economy. It stresses the real terms determine the basic economic decisions such as resource allocations but not the nominal terms. The examination here involves testing Taiwan-US and Canada-US cases; one is a growing small economy and the other is a developed medium economy, each highly related to the US economy, but under different international monetary systems and also under different levels of openness in their financial markets. Different economy sizes relative to foreign countries bring some features to the dynamic structural models. In addition, the state of economic development might be another factor responsible for some particular and interesting empirical results.; Findings and conclusion. The main findings from the empirical results in Canada's case are as follows. When productivity rises, the NATREX depreciates due to the wealth effect that dominates. When the Canadian savings rate declines, the NATREX depreciates due to the effect of borrowing to finance current consumption. The US real long-term interest rate weakly influences the Canadian economy. Generally, from the empirical results of the error correction component model, the NATREX does respond to the fundamental determinants; it does adjust the short run deviations gradually to the long run equilibrium relationship. In Taiwan's case, when productivity rises in the tradable goods sector, the relative price rises under the exogenous terms of trade and appreciates the NATREX; when the Taiwanese savings rate decreases, it pushes the relative price up and appreciates the NATREX. That the correlation coefficients between the NATREX and the actual exchange rate is 0.70 in Canada's case, and it is 0.95 in Taiwan's case fully support the NATREX fit the model quite well. The real fundamentals do sustain real exchange rate movements in the long run. |
